Do you dream of owning your own rental property? In this guide you will find knowledge and tips on what to think about. Here you also get an idea of the type of responsibility you have as a property owner.
So, how do you buy rental property? Housing or premises?
Those who have been in the industry usually say that housing is best to start with because there is a lower risk. It is easier to find tenants and understand the need. It is also safest to invest according to the property’s cash flow and not speculate in “flipping” properties and hoping someone is willing to pay more than you did.
When you buy a property with premises, you must match with the right tenant and usually adapt the premises to the tenants.
The agreements run for longer periods and there is a risk that the premises will be empty for a longer period. The e-commerce trend has left many business premises empty.
In a recession, warehouses and industrial premises can also be unleased when tenants terminate their agreements.
Of course, there are disadvantages with housing as well, some are that there are stricter rules and that the direct return will be lower than for commercial premises.
Where does the money come from?
It is common for those who go in and invest in individual real estate objects to have a large amount of capital to begin with.
Usually, the surplus capital comes from a business where profits have been saved. Once the money is invested in real estate, it has only been taxed in one step, ie via corporation tax on the profit.
If you come from the private side, it is probably successful equity investments that have created a need for diversification due to a large accumulated capital.
Why invest in rental property?
The most common arguments for investing in rental properties are:
- Stable and predictable cash flows that come monthly
- Historically been a good investment for capital
- The business model is easy to understand and calculate and does not change over time
- Scalable, ie the profitability gets better the more / larger fastights you own
- There are many tax benefits to real estate
- Good access for diversification if you already own e.g. companies, securities or forest
- Easier for the children to take over the business compared to e.g. a technologically advanced company or other rapidly changing industries
- A management company can manage operations and finances in the event of a sudden death or if you no longer want to be operational
- Banks like to lend money to rental properties in comparison to giving loans to start-ups, small business owners, cyclically sensitive companies or securities
When are you ready to buy the first apartment building?
Most people wait until they can buy an apartment building with 3 or more apartments.
Of course, you can start with a single-family house, but it does not scale as well with work, time and finances. So it pays to save up the capital needed for 3 apartments or more.
It is really best to start with 10 apartments, but you also have to start somewhere to learn and develop.
About scalability: It is more scalable and cost effective to have a roof to renovate, to have a facade to paint to have a lawn to mow and so on.
You get higher margins and cash flow that way, which makes your business more valuable.
The usual development phases you go through are usually to first invest in houses with 3 apartments, then houses with 10 apartments and finally rental houses with 30 apartments plus.
How much money do you need?
It depends on the location (big city or country), bank contact (50% loan or 75% loan), renovation needs, experience and what return requirement you have (direct return eg 2-12%).
Generally, it is about 1-300,000 dollars in cash contribution for the first purchase.
If you are only allowed to borrow 50%, it may have to do with the property having a bad location, having a high risk or you as a new property owner having to prove yourself to the bank first.
If you have a good bank contact in the corporate department who has confidence in you and you are also good at negotiating, you can increase the loan-to-value ratio so that not as high a cash contribution is needed.
You have an advantage if you are an old customer of the bank and they can see how well run your other companies are.
A well-managed personal finances are also positive, see it as your CV or business card.
Another advantage is if you can show the bank that you have a team of people behind you. Especially if you do not have the skills yourself.
It can be people in your network with knowledge in real estate, construction, plumbing, electrician, lawyer, accountant and so on.
The bank wants you to be a problem solver and manage their ownership well.
The advantage of using other people’s money (the bank’s money) is that you get a return on your equity and the bank’s capital.
Your return will be better the higher the loan you have, but the risk obviously also increases. This is why loans can be a good thing as long as the money goes to wise investments that do not diminish in value.
During the time that you gather knowledge about real estate and build up your start-up capital, you can invest your money in e.g. a savings account or in shares.
If you have a high mortgage, it is important that you have good tenants who pay their rents, otherwise there is a risk that the bank will take your property from you.
Make sure you know everything about the city, the countryside, the location, the house and the tenants before presenting your plan to the bank.
What are the risks of investing in rental properties?
Now it became a long list of risks below. But it is equally important to see the opportunities in every business. Otherwise you never dare to get shot and start. Here are some risks:
- High vacancy rate, which means you do not get your apartments rented
- That you choose bad tenants who disturb neighbors, do not pay their rents, sublet and destroy the apartments they live in. Tenants who misbehave create a negative spiral for your business
- The renovation needs were greater than you expected or it turns out that there are hidden faults, which can be a disaster as you can not stand financial blows in the first years
- The interest rate on your loans rises more than you expected, which means that your cash flow is not enough to pay the bank. This means that the bank has the right to take the property from you
- A tenant sues you because you and the property have not been able to live up to the legal obligations you have towards the tenant.
- One or more deaths occur in your apartments due to fire or murder. It is something that is tough to be involved in psychologically, and it can lead to you not wanting to run your real estate company further. It is worth noting that the risk of fire increases with older tenants who are in the risk zone for dementia and at Christmas when many want candles in the apartment
- You miss that a building permit is required, which means that you get expensive penalty fees that you and your company are unable to pay.
- Damage to facades, windows or doors that can quickly become costly
- Tenants begin to terminate their tenancy agreements because a tenant is a criminal or abuser or otherwise creates insecurity in the area
- Tenants who call on private phones, family members’ mobiles, go home to your private home, write slander on social media, call and threaten. Harassment can occur at e.g. eviction or that the tenant has unreasonable demands. Tenants can also have neighbor feuds between them and call you to sort out the quarrels
- If you have bought a property in the same place as you live in, tenants can come to you in the grocery store or when you have quality time with the family. Then they often have complaints or want you to help them air the elements. The risk is that you or your wife will find it unbearable in the long run
- As a landlord, you may not prohibit smoking in the apartments, even if it is stated in the rental agreement. However, a tenant may be obliged to restore the apartment to its original condition, but there is a great risk that the tenant will not be able to pay for the renovation and you do not want the apartment to be empty forever. It will ultimately be a cost you have to bear
- Tenants have joined forces via the Tenants’ Association and demand a rent reduction due to shortcomings such as cold in the apartments, noise, poor TV reception, poor ventilation, no hot water in the shower, bad smell and disturbance from neighbors.
- You buy a rental property that is fully let, so you are not allowed to choose tenants yourself, which can lead to lost rental income. You can also not terminate the lease as existing tenants have security of tenure
- The situation and demand will deteriorate over time as employers, shops and schools in the area disappear
- In the beginning, you and your personal finances are extremely focused on a single property object. There is little room for error
- You are careless with anti-skid and snow removal on the roof and around your property. Someone slips or gets an icicle in the head, which can lead to damages and imprisonment
Insurance as a property owner
There are risks that you can insure against.
Almost all insurance companies have special property insurance policies aimed at you who own apartment buildings. Make sure you are insured against:
- Fire, water leaks, pests
- Loss of rent due to damage
- Damages, legal costs
- Theft and vandalism
- Accidents in public areas
Remember that insurance companies often have counterclaims for the insurance to apply.
For example: In order for your insurance to apply if someone slips outside your property, it is required that you can show that you have routines for snow removal and sanding.
Responsibility as a property owner
- Delimit areas where snow or icicles can fall from roofs and injure people. Be sure to clear roofs of snow and ice for preventive purposes so that people or roofs are not damaged. If you or your staff are to do it yourself, a seat belt is required, otherwise it is common to hire professionals instead. If there is too much snow on the roof and the building is damaged, the insurance does not apply
- Everything you can stumble upon or cut yourself on must be removed from the plot
- Remove loose objects or lash them when there is a storm so no property or person is damaged
- Check at regular intervals if roof tiles and downpipes are firmly attached. Otherwise, someone could be seriously injured
- Check for trees that are too close to the property. There is a risk that they blow down on cars, the property and in the worst case people. Beware of trees that have started to rot from the inside, these are especially sensitive to storms. Most insurances do not apply if a tree blows over due to a storm and damages the building.
- Beware of the risk of fire when you hire contractors who will perform welding, cutting, soldering, roofing and more
- You are responsible for having correct evacuation signs, fire ladders, escape routes and fire extinguishers in public areas
- If it is a new production of a property, you are responsible for handicap adaptation of the entrance, elevator, kitchen and bathroom. You also need fire cells in the apartments
- It must not be more than 26 degrees hot or 18 degrees cold in an apartment. Make sure that the heating system works correctly
- All electrical cables and connectors must be secure, nothing must hang loose
- That all public areas such as basement, attic, laundry room, stairs, entrance and parking are properly lit with lights
Is it a passive income to own rental properties?
No, it takes a lot of work, responsibility and time in the beginning before you can scale up your business and make it more efficient.
Of course, the actual rental income is passive and recurring if you have good tenants.
But behind these are some jobs. When you are at the beginning of your career as a property owner, you need to do maintenance and administration yourself to get profitability in your business.
Owning a rental property is not like owning real estate shares on the stock exchange. But it is a company where you have a great responsibility because rental apartments are an important function in society.
You have to like working with buildings and people.
Otherwise, it is better to buy shares with the same direct return as rental properties. Sure, you do not get the same leverage on your equity without a loan, but you avoid liability and time costs.
Owning an apartment building is a service job and you will soon notice that the work is high and low. It is about handling questions, complaints and dismissals by phone and email.
You must be able to leave keys, help locked out, collect missed rents, arrange agreements, advertisements, fix power outages, replace the refrigerator and freezer before the tenant’s food goes bad, handle floods, snow, fire, broken windows, neighbors’ quarrels and vandalism.
Of course, not everything happens at once, but over time you will come across some of the examples.
You should be reachable throughout the day, even if you do not always respond at once, and give a nice welcome.
The positive thing is that you will soon have a good system for the chores, which is needed if you want to scale up with more properties in the future.
Owning rental properties is a business, a business, just like a car repair shop or clothing store.
Many people beautifully paint rental properties and believe that they are just standing there and that the money comes in by itself without any job. Then you do not have realistic expectations.
What are rental properties usually valued at?
Apartment buildings are valued on what operating net you have in your business.
Normally you have to pay 10-25 times the operating net.
In cities it is in the more expensive range, while in sparsely populated areas you usually have to pay 10-15 times the operating net.
Choose your tenants carefully – they are your most important asset
Many people think that the property itself is the most important asset. And that’s true to some extent, that’s where the safe and the deposit are.
But the actual cash flow, the blood circulation in your business, is generated by your tenants.
Therefore, it is important that your tenants have a good ability to pay so that the rental income comes in every month.
Tenants with payment remarks or history with the Enforcement Officer are unfortunately problems for your business and should be avoided.
It has to do with the fact that behind payment remarks there is a bad habit of being careless or irresponsible when it comes to one’s personal finances and bills.
And habits do not change people overnight. Then it is better to do proper credit checks before signing a lease with a tenant.
You choose which tenants you want to rent to, there are no special laws or requirements for queuing systems.
How to choose a good tenant?
Start by advertising on your local newspaper and on social media. When you then have a tour of the apartments, you can feel the people who are there and make notes.
When you then see who wants the apartment, you can do credit checks and then choose those who felt right and have their finances in order.
In general, those who are 40-50 years old have a good job and personal finances.
What do you do if the tenant does not pay?
You send out a payment reminder and hope they pay. If not, you can terminate the tenant in writing and turn to debt collection or the Enforcement Officer.
You must also inform the social services about the dismissal.
If someone is late with the rent, it is best to call and remind about the rent and ask if there is any special reason. Sometimes there are good reasons for being late with the rent.
General tips for you who are going to invest in rental properties
- If you buy a property as a private individual / sole proprietorship, the interest rate is usually lower than for a company. It has to do with the fact that there is a financial history of you as a private person and that you become personally liable for payment. If you have a start-up company, the interest rate will initially be higher. But instead, you usually do not have to personally go on bail if you have a cash investment of 25% and higher
- Remember to have a sufficiently high direct return to cope with high interest rates. If a high direct return does not exist from the start / purchase time, make sure to be able to make improvements that result in a high direct return.
- When buying a property, there are one-off fees called stamp duty. For private individuals / sole proprietorships it is 1.5% of the purchase price and for limited companies it is 4.25%.
- Remember that the tenancy law requires that you have a storage of around 3 sqm available for each tenant
- Investigate the possibility of charging for parking. As a landlord, you can price parking spaces freely without the Tenants’ Association’s involvement
- You may not deduct VAT when you rent out homes as it is not taxable income. However, you may deduct VAT on the share you rent to companies if you have a retail premises or similar in your property.
- When you raise the standard of an apartment by making trunk changes, renovating kitchens and bathrooms, you can make rent increases when it’s done. The increase must be reasonable in relation to other apartments in the locality with the same standard. Average rent increases are between 30-40%, according to surveys conducted by the Tenants’ Association
- Many smaller landlords make agreements with their tenants for lower rents in exchange for mowing the lawn, shoveling snow or cleaning the stairwell. The problem is that according to the law, it is considered gainful employment and must be taxed with social security contributions. The landlord must thus pay salary to the tenant, so rent reduction may not be used. Also worth noting: From a legal perspective, you end up going on damages if someone slips outside your property, even though it was the tenant you had an agreement with who shoveled and sanded carelessly
- Clean the downpipes before winter when the leaves have fallen off. If there are trees near the house, the downpipes are quickly refilled. Which means that water flows along the facade and splashes up on the house foundation. When it gets freezing cold, there will be cracks and frost blasting
- Always make a credit report on the tenants who have sent an application for rent
- You can ask tenants to deposit 1-3 monthly rents in advance when moving in to reduce the risk of no rents in the future
- If you have premises in your property, always make proper leases with tenants. If you are going to rebuild or renovate at the tenant’s request, make sure that you agree before construction begins and write down your agreement in writing so that the tenant can not withdraw or change afterwards
- Make sure to create ready-made processes and systems as most work steps return when you are a landlord. In addition, it is easier to hand over the tasks to someone else if everything is documented and organized
Just like in all industries and for all new entrepreneurs, it can feel tough in the beginning with high walls as an obstacle to overcome.
But as you learn and gain experience, it feels easier.
You grow into responsibility as a property owner. You’ll make mistakes, and that’s okay because that’s how you learn.
Do not let yourself be discouraged by everything you need to know, you will have time to learn on the journey as well.